The Comprehensive Guide to Product Pricing Strategy

Blog
Nov 15, 2022
6 min read
Product pricing may sound simple — consider your costs, aim to make a profit — but the reality is that there’s much more to it.

Pricing strategies also must take into account factors like larger market conditions, competitive landscapes, seasonality, and current demand. The market is constantly evolving, so pricing must be evaluated regularly and adjusted as needed. Further, the best product pricing model for one type of business may not be as effective for another.

In other words: product pricing can be complex, and finding the right strategy for your business can be a challenge. 

More importantly, however, pricing presents a huge revenue opportunity for companies that do it right. An optimized product pricing strategy makes go-to-market strategies more successful, increases profit, creates competitive advantages, drives faster growth, and elevates customer satisfaction levels.

In this guide, we’ll help you find the right product pricing strategy to help your business achieve these results and more. We’ll cover:

  • 7 of the most commonly-used product pricing models
  • Their benefits and challenges
  • The types of companies and scenarios for which they’re most effective
  • How to choose the best product pricing strategy for your business

Let’s get started.

7 Proven Product Pricing Strategies

Competitive

Competitive pricing uses the existing market as a baseline on which to build your own pricing strategy. The aim is to make price a differentiator — a factor that customers will use to choose your product over other alternatives.

This approach is often used by companies in crowded markets where product differentiation is difficult otherwise — i.e. a market where the same product is made by many companies and customers won’t have particularly high brand attachment (ex: batteries by Energizer, Duracell, Panasonic and many others).

When competitor prices are wide ranging, brands may not necessarily decide to go lowest of all with this strategy, but rather place themselves somewhere in the middle of the pack. For example, you may want to price your products lower than the most premium brands but higher than bargain options, knowing you’ll strike the right balance between quality and affordability. 

Cost-plus

Cost-plus pricing focuses on straight profitability, measuring exactly what it costs to produce and sell a product, then marking it up to earn a profit percentage. It’s best used by consumer products companies putting actual products on the shelves vs. digital product providers who won’t have a high cost of production to worry about.

Typically, cost-plus pricing is done by percentage (ex: you want to earn 50% of the total cost to produce in profit after sale). That means you’ll need to adjust prices when your production costs increase to maintain the same level of profitability.

Conversely, you can keep prices the same if production costs drop and enjoy an additional percentage earned. 

Value-based

Rather than looking inward at production costs or sideways at competitors, value-based pricing looks outward to customers to determine the right price. It asks: What would a customer be willing to pay for this product? Demand plays a role, as well as the market’s perception of your brand and products.

This pricing strategy is best for companies that sell unique products vs. those that produce commodity items. That’s because with commodity items, comparisons to competitor pricing inevitably impact market perception, which means pricing flexibility is more limited.

Value-based pricing requires consistently high product quality and brand service and  good rapport with your customer base. To keep pricing optimized with this approach, brands must be continually engaged and in tune with their customers to understand value perception and monitor whether it changes over time.

Freemium

Freemium pricing is designed to get users to try out your product in order to drive an actual sale later on. The freemium model has exploded in popularity with the rise of subscription-based mobile and SaaS applications. Rather than offering a full free trial, companies provide unlimited access to a basic version of the product, allowing users to see its value — and the additional features they could use if they had a premium subscription.

The main challenge with freemium pricing is maintaining the right balance of free and premium features. Offer too many for free, and users won’t be motivated to buy premium access. Put too many features behind a paywall, and users may fail to see full value potential. 

Fortunately, the digital nature of freemium products makes it easy for companies to test and adjust their freemium model until they get it just right.

Dynamic

Dynamic pricing is flexible and always evolving, aligning with market and consumer demand. It’s challenging to maintain a dynamic pricing strategy without a sophisticated data strategy and robust infrastructure to support it, which is why you see it most utilized by large companies like hotels and airlines.

The benefit of dynamic pricing is that it maximizes profitability at all times, using algorithms to consider a multitude of factors and pinpoint the exact best price point for a given month, week, day, or even hour.

Skimming

Skimming is a pricing model that starts by pricing products high, then slowly decreasing it as demand fades over time. This strategy is used most commonly by tech companies that release new versions of the same product periodically — like the iPhone.

It can also be used by retail brands that release seasonal items. For example, a summer clothing line may be sold at a certain price point that is then lowered when the fall line is released.

Penetration

Penetration pricing is the opposite of skimming, it starts low and aims to use price to stand out from competitors. It’s used commonly by companies launching a new product with high competition — the price starts out low enough that it’s a no-brainer for customers to choose it. Then, as they realize its value, the price can be elevated.

The obvious issue with penetration pricing is that it has to be a short-term strategy— companies can’t sustain extremely low-margin (or even no-margin) prices for long. Further, it’s often not an option for companies like startups or small businesses without a revenue cushion to balance out temporary losses.

How do you choose the right pricing strategy for your business?

After reviewing the pricing strategies listed in the previous section, you probably have a decent idea of which pricing models would fit your business. To narrow it down to the very best option, here are some important factors to keep in mind:

Value Metric

Your value metric is the actual thing that you charge for. For instance: An airline prices tickets per seat, an SaaS company may charge per platform user, and a consumer products company charges per unit.

Determining your value metric is important because it ensures the price you set is always aligned with the value you offer. For physical products, this is more straightforward, but it really comes into play for B2B and software as a service (SaaS) companies offering more unique bundles of features or services.

Consider a SaaS company with multiple pricing tiers. Relying on features alone as your value metric could result in missed revenue opportunities — a company with 100 users would end up paying the same as a customer with 10 users.

If instead you consider number of users as a primary value metric driving price, you can charge for additional users and thus earn higher profit from your larger customers, which makes sense because they’re getting more value from your product via wider usage.

In practice, it might look something like this: a flat monthly subscription fee for a certain bundle of features and 5 users, then $100 monthly for every additional user.

Target Customer

Understanding the companies and people you sell to is central to your pricing strategy. They’ll have certain budget ranges you’ll need to price within in order to capture their business. If you know who you’re targeting and see a misalignment between your pricing strategy and their average ability to spend, you’ll know sooner that you need to make adjustments (rather than after you’ve already launched).

Creating detailed buyer personas helps streamline this process. Buyer personas should always be goals-based (what’s motivating your buyer to make a purchase?) and include quantitative data as well as qualitative attributes to help you evaluate spending power. For B2B companies, it’s also important to use ideal customer profiles to describe buyers at an organizational level.

Business Model and Product

Your business model determines which pricing strategies make inherent sense for you to use. For example, a freemium model won’t work for companies selling a commodity product, and a simple cost-plus approach wouldn’t make sense for an airline or hotel.

Use your business model and product knowledge to narrow down your product pricing options to those you can logically use, then strategize around the best choice for your unique offerings.

Optimize Product Pricing with Revenue Intelligence

Maintaining the right price points to optimize your go-to-market strategy requires a data-driven approach — one that’s best supported by an Intelligent Revenue platform. With Xactly, you can uncover critical sales insights and monitor performance to ensure your product pricing model, sales process, and customer demand are always in alignment.

Learn more about how Xactly can drive greater confidence across your go-to-market teams, or schedule a demo to get started today!
 

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